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Liontrust's John Husselbee's arguments in support of balanced funds are lame
I first wrote about the challenges faced by balanced funds five years ago and continued to write about them. Then, an article of mine in mid-October last year suggesting that they were broken really put the cat among the pigeons.
Given the huge amounts of money invested in such funds, whether passive balanced funds or those that were 'passive in disguise' (active balanced funds that are generally part of a risk rated range and thus constrained with respect to asset allocation) the backlash has been severe. Liontrust's John Husselbee is the latest to join the chorus of voices criticising those like me who have questioned the validity of balanced funds and their flagship, the 60/40 portfolio.
I respect John immensely, though I was not impressed by his rebuttal argument, as set out in a recent Trustnet piece titled, There’s never been a better time for a 60:40 portfolio.
Let's take six of his statements one by one (the article appears to have been a write up of an interview with John and where possible I have removed the 'Husselbee said that' phrases for the sake of tidiness).
1. "In the past 100 years, 2022 was only the fourth time that bonds and equities both lost money."
My comment: There are a couple of things wrong here. First, it appears that the losses referenced are in nominal terms (in fact there was not a single mention in the entire article of 'real', inflation-adjusted', or indeed even of 'inflation'!) John would know the importance of quoting gains and losses in real terms - as I like to say, nominal returns don't buy you real bread and milk.
There being no mention of 'inflation' anywhere in the piece is particularly surprising. It is what caused balanced funds to perform so poorly over the last couple of years or so. Indeed it is generally the main reason why bonds perform particularly poorly from time to time, along with rising real interest rates and, in the case of specific bonds, rising default risk.
However, the main problem I have with the statement is that balanced funds and forms thereof are generally held in retirement accounts as long-term investments. What happens in one particular year is irrelevant. And of course you don't need both bonds and equities to fall for balanced funds to fall; you just need one to fall more than the other rises. And you can have a multi decade period of poor balanced fund performance which contains the odd year of very good performance due to good performance of both bonds and equities.
From 1965 to 1981 (chart 1) US balanced funds in real terms fell by 35% (UK equivalents would have been similar). Does it really matter to retirement savers that there may only have been one or two years during that period in which bonds and equities both lost money (chart 2)? Also, what we have seen from balanced funds the last two and a half years could be just the start (chart 3).
Chart 1: A 50/50 US balanced fund has had multi-year periods of poor performance
Chart 2: The sixteen years from 1965 to 1981, however, were dreadful ones for balanced/risk rated funds
Chart 3: The last two and a half years could be just the tip of the iceberg
2. "Such poor performance for bonds, coming at a time when equities also fell, has led many commentators to claim the 60:40 portfolio is no longer fit for purpose. However, Husselbee said that these critics were looking at it from the wrong perspective. He pointed to data showing that over the past 30 years, using the MSCI World index as a proxy for equities, there have been just two occasions when a negative year was followed by another negative year (1999 and 2000). For bonds, using the Bloomberg Global Aggregate index as a proxy, there was only one occasion when this happened – 2011."
My comment: Again, why would two year periods matter to long-term investors? And why would nominal not real returns matter? And why would equity and bond performance in isolation matter? For balanced funds, by definition, it is the combination that matters.
3. “We've seen a significant repricing in bond yields. We've seen a significant repricing in equities as well. And if there was ever a time for 60:40 to work, if there was ever a time to get above-average returns over the long term for 60:40, it’s when yields are high and equity valuations are low.”
My comment: yields on both equities and and bonds are higher than they were but that does not mean they are high. In a long-term historical context, they are still low.
4. "One of the reasons why some commentators may be shying away from the these ‘balanced’ portfolios is that this is the first time they have seen yields and interest rates this high and may be under the impression that this is in some way abnormal. However, the current environment more closely resembles typical financial conditions than the post-financial crisis period."
My comment: I do not understand this. Surely if people thought yields were abnormally high they would be drawn towards balanced funds, not shying away from them. And, yes, yields are more typical (higher) than they were following the financial crisis but this does not make them attractive.
5. "The Federal Reserve raised rates by 4 percentage points in just seven months, when such an increase would usually take two to three years. However, this spike has suddenly made bonds attractive once more, while the volatile macroeconomic backdrop has created further opportunity to add value."
My comment: Real bond yields, whether in the UK or elsewhere, are certainly higher than they were a couple of years ago, making them more attractive. But at or around 0% (1% in US) they can hardly be called attractive. In the past they have been as high as 4 or 5%. In other words, 0% is not cheap.
I would agree that the volatile macroeconomic backdrop has created further opportunity to add value, but then I've never known the macroeconomic backdrop not to be volatile. It's just that some times are more volatile than others.
6. “If I were a bond manager who had just enjoyed a 30- to 35-year bull market, I might have thought, ‘okay, that's the time to hang up my boots’. But one year on I would probably be thinking ‘hang on a minute, there are some fantastic opportunities here’, because my market has just been repriced back to yields I haven't seen for the past 10 years, the world is beginning to contract, central banks are becoming more independent of each other and I've got a wider opportunity set. It is a pretty exciting time for bond managers again.”
My comment: I do not think that a ten year context is appropriate. Yes, yields are higher than they were ten years ago, but that doesn't make them attractive. They are still low in real terms, and still well below where they have been at times in the past.
Ultimately, this entire debate can be distilled down to what inflation does for the next decade or two. If it falls as it is currently doing and remains low, balanced funds will be just fine. John will be right, and I will be wrong. If it falls and goes back up again (as I expect) they won't be.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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